Resale price method

Definition

The resale price method is a pricing strategy used to determine the appropriate transfer price for goods sold between related parties, particularly when the reseller adds a markup to the cost of goods purchased. This method involves calculating the resale price of a product and then subtracting an appropriate gross margin to arrive at the transfer price. It's widely utilized in transfer pricing to ensure that transactions between affiliates are conducted fairly and in compliance with tax regulations.

5 Must Know Facts For Your Next Test

1. The resale price method is most effective when there is a reliable resale price available, allowing for accurate calculation of the transfer price.
2. This method is particularly useful for companies that purchase finished goods and resell them without substantial modification.
3. In using the resale price method, companies need to determine a reasonable gross margin that reflects market conditions and comparable sales.
4. It helps to prevent profit shifting between jurisdictions, ensuring that profits are reported where economic activities occur.
5. The resale price method can be challenged by tax authorities if it does not align with market practices or if the gross margin used is not justified.

Review Questions

• How does the resale price method ensure compliance with tax regulations regarding transfer pricing?
  • The resale price method ensures compliance by establishing a fair transfer price based on actual market resale prices minus an appropriate gross margin. By aligning the transfer prices with market practices, it reduces the risk of profit shifting and ensures that income is reported accurately where economic activity occurs. This adherence to market standards helps companies avoid scrutiny from tax authorities who might challenge pricing strategies that seem non-compliant.
• Compare and contrast the resale price method with the cost plus method in terms of their application in determining transfer prices.
  • The resale price method focuses on determining the transfer price based on market resale prices, making it suitable for resellers of finished goods. In contrast, the cost plus method bases its pricing on the costs incurred by the seller plus a markup. While both methods aim to establish fair transfer prices, their applications differ significantly; the resale price method is often more appropriate when resale prices are readily available, whereas the cost plus method is useful when dealing with unique products or services where comparable prices are not easily determined.
• Evaluate how the arm's length principle interacts with the resale price method in establishing acceptable transfer pricing practices.
  • The arm's length principle is central to establishing acceptable transfer pricing practices, as it requires that transactions between related parties be conducted as if they were between unrelated entities. When applying the resale price method, adherence to this principle means ensuring that the calculated gross margin reflects what would be charged in an open market scenario. This alignment helps prevent tax avoidance strategies and ensures fair competition by promoting transparency in intercompany transactions, making it essential for businesses to justify their chosen gross margins against market benchmarks.

Related terms

Transfer Pricing: The pricing of goods, services, and intangibles between related business entities, which can affect taxable income and compliance with tax regulations.

Cost Plus Method: A transfer pricing method that calculates the transfer price based on the costs incurred by the seller plus a markup for profit.

Arm's Length Principle: A guideline in transfer pricing that requires transactions between related parties to be priced as if they were between unrelated parties, ensuring fair market value.